Politics Will Still Keep Pound Under Pressure. By Nicholas Hastings

The promise of a U.K. deficit reduction is one thing for sterling. But, politics is another.

As David Cameron settles in Number Ten Downing Street it is clear the Conservatives will be able to deliver their plan for cutting public spending by GBP6 billion in the next year.

This may be tiny in the larger scheme of the GBP166 billion deficit, but it does show financial markets that Cameron has the upper hand in his negotiations with the Liberal Democrats in terms of introducing fiscal discipline as soon as possible.

However, that is about as far as the good news for sterling goes.

Accelerated fiscal tightening will only mean one thing--the economy will slow down again even more quickly than it might have otherwise and the Bank of England will have even less reason to start considering rate hikes.

If anything, Bank of England Governor Mervyn King reminded markets Thursday that the central bank could still adopt more quantitative easing given the downside risks to economic growth.

With annual growth only likely to amount to 1-2% a year over the next few years, as opposed to the 3% seen in the recent past, the pound can hardly expect support from interest rates for some time to come.

Then, there is how the new administration presents its spending cuts.

Obviously, Cameron will blame his predecessor in Number Ten for the deplorable state of the county's finances. But, he has to be careful not to overdo it.

"Cameron has to avoid a 'Greek moment' by presenting the current budget situation in too gloomy terms as this will make highly nervous rating agencies even more sensitive," warned Hans Redeker, head of global foreign exchange strategy at BNP Paribas in London.

But, it is state of the coalition and the high risk that it will fall apart that will keep downward pressure on sterling.

Cameron's decision to form a formal coalition with the Liberal Democrats may well provide the best option for a stable government after last Thursday's inconclusive general election.

However, as the first coalition in 80 years between two parties with basic ideological positions that are miles apart, chances are that agreement on non-fiscal issues may will prove much more divisive.

For the moment, the differences are being papered over with the Liberal Democrats even suggesting that they will drop their demands for an end to defense spending on the Trident nuclear deterrent and support the Conservatives' refusal to hand over any more power to Brussels.

With the Liberal Democrat leader Nick Clegg, who has been made deputy prime minister as part of the deal, these sorts of compromises may prove difficult to achieve given the strength of the left-wing element in his parliamentary party.

So, rather than relaxing now that the new government is in place, financial markets are likely to remain on edge--ever mindful that, as Commerzbank reminded us, "traditionally hung parliaments last months, not years."

With the risk of another election before the end of the year hanging around its neck, the pound is hardly likely to be able to establish any sustained gains over $1.50 just now.

See how quiet the pound has gone sine that brief rally:




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Currency markets were generally in a brighter mood early Thursday in Europe with a lack of any more negative developments in the euro zone and bits and pieces of economic data pointing to a continued global upturn helping sentiment to improve.

As stock markets gain, with the Nikkei up 2.2% and the Shanghai Composite up 1.5%, high yielders in general were getting some respite.

Sterling was among those, rising to $1.4886 by 0645 GMT from $1.4826 late Wednesday In New York, according to EBS.

The euro was up at $1.2665 from $1.2629 and at Y118.36 from Y117.69. The dollar was up at Y93.45 from Y93.17.